Positive economic indicators could support an economic
picture that might see GDP growth exceed 3%.

Uncertainty and risks are potential headwinds in an otherwise
upbeat scenario.

We have decided to take on a modestly more defensive
investment positioning, particularly with respect to fixed income.

Our current outlook"Optimismůmakes people go
out andůstart businesses and spend and do whatever is necessary to get
the economy going." – Ben Bernanke

Optimism is a beautiful thing, as the former Federal Reserve
chairman noted in a 2012 interview. And this is no less true today, when
– in the wake of the very volatile showing we saw in the first half of
2014 – it's understandable that recent positive economic indicators
might awaken a renewed sense of hopeful expectation.

The Investment Strategy Team (IST) had its monthly meeting last
week to discuss its weightings and outlook.¹ We find that economic
activity is pointing toward a more consistent performance in the second
half of the year, where growth is likely to range between 2.5% and 3%.
The strongest story supporting the economy may be coming from the
employment front, where job growth last month reached 288,000 new
nonfarm payroll jobs, the unemployment rate slipped to 6.1%, and job
openings reached 4.6 million. In our view, all of these could support an
economic growth picture that might see GDP growth exceed 3%.

Furthermore, we find that data supporting the economy have also come from a wide assortment of other sources, including:

Auto sales have almost returned to 17 million units annually.

The Market US Manufacturing PMI is well above 50 at 57.3 pointing toward strong expansion.

The NAHB Housing Market Index, an indication of home builder sentiment, exceeded expectations with a reading of 53.

Reasons for caution
Despite the positive signs, we have tempered our outlook due to the following mild headwinds that continue to blow:

Policy uncertainty. A shift toward active monetary tightening by the Fed appears likely by mid-2015, with the risk that this takes place sooner rather than later. While the start of rate increases doesn't necessarily mean a downturn for economic activity or equity prices (and could even be stimulative as interest income streams for savers begin to flow), uncertainty around the timing and impact on markets will likely build.

Unknown economic direction. While the U.S. economy is expected to grow, residual issues involving consumer spending, housing activity, productivity growth, income growth, and labor market slack, while not considered threatening, could evolve in more ominous directions.

Fragile global expansions in Europe and Japan could affect the ability for these regions to accelerate their economies, which will likely be decided over the next 6 to 12 months.

Escalating international tensions. The scope of any individual problem is not by itself overly threatening but concerns over the increasing disorder around the world may pose more problems as time passes. With the U.S. taking a less active role, the breadth of hot spots has expanded, along with the risk of mistakes, as demonstrated by the recent tragic destruction of a Malaysian jetliner.

Our investment positioning
From an overall perspective, our belief that the expansion still has time to run and that growth will be modest supports our continued positioning favoring equities and growth. However, against a background that includes the potential risks listed above, we have decided to take on a slightly more defensive position.

The prospect of rising short-term interest rates and a flattening yield curve should not bode well for short-term investment-grade bonds, so we have proactively begun reducing this position, putting money into cash which we feel could outperform bonds, provide safety, and provide us with a source of liquidity to respond to new opportunities. We have added to our non-fully diversified portfolios multi-strategy liquid alternatives, which will give us the ability to adjust exposures to fixed income and equity markets with respect to interest rate sensitivity, credit exposure, and downside protection. Given the use of liquid alternatives, the tactical allocations in this area can be easily changed as market conditions warrant. Our thoughts have not changed on inflation hedges and we remain underweight, since we see inflation as a relatively benign threat.

As we look at the performance gaps between value and growth, and between large cap and small cap, the markets are very near the biggest levels seen earlier this year and at levels that have historically been considered extremes. For that reason and as part of our more defensive posture, we have reduced our exposure to small-cap equities. That said, we maintain our small-cap overweight, since making major modifications now could result in locking in losses at peak levels. In our view, patience is the best course of action at this time.

Investments:
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 May Lose Value.

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